Thoughts on Monetary Theory and Policy and some not-so-random random economic writings

Saturday, March 22, 2014

Economic History: Panic of 1896

In my blog posts, I have been trying to write multiple type of posts, such as posts on someone's paper, someone's article, or the WSJ articles. This time, I wanted to do little bit of research on economic history.

The Panic of 1896 is one of the pre-World War I economic contractions that was caused by the gold standard of the late 19th century and declining world price in terms of gold. The panic, according to the NBER business cycles dates, dated from December of 1895 to June of 1897. During the panic, the business activity declined by 25.2% and the unemployment rate increased from 13.7% in 1895 to persisting 14.5 % in 1896 and 1897 following a decrease in unemployment rate from 18.4% in 1894 (Romer, 58). At the beginning of the contraction and the end of brief recovery from the Panic of 1893, the aggregate output of the economy hadn't reached the peak of the previous business cycle; therefore, the Panic of 1896 is often considered as a continuation of the Panic of 1893. The Panic of 1896 was caused by a huge
drop in the Treasury’s gold reserve because of the public suspicion for departure from gold standard, whereas the Panic of 1893 was caused by bank runs due to concern over the solvency of the banks.

Cause of the Panic

Deflationary period

The panic relates to the US business cycle contraction defined by NBER as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

A slowing of the rate of increase of the world’s stock of gold, an increase in the number of countries on the gold standard and a higher growth rate of the total economic output resulted in a deflationary period from 1875 to 1896 with a rate of 1.7% a year in the US (Friedman, 69). The US money stock increased only 6 percent from 1891 to 1896. In meantime, the nominal net national product decreased by 1 percent per year on average, whereas the real net national product increased by 2 percent per year (Friedman and Schwartz, 97). The rate of growth of the real output, which was greater than that of growth of the money supply during this period, put pressure on nominal price.

Prior to 1873, the US was under bimetallistic standard. The Coinage Act of 1873 essentially demonetized silver by omitting the silver dollar of 371.35 troy grains of pure silver, and the Resumption Act of 1875 further established the gold standard. During this deflationary period, political movements for free silver coin and departure from the gold standard in the
US were increasing as the United States needed an increase in the money stock to stop the deflation. Farmers, being unable to pay their debts with lower prices, and silver producers, who was hit by lower silver price, formed the People’s party and The National Silver party.As the gold reserve in the Treasury dropped to $45 million in January of 1895, the public’s worry for the maintenance of the gold standard, which was proximately originated by the Sherman Silver Purchase Act of 1890, put more pressure on gold reserves.

Election of 1896

In July of 1986, William Jennings Bryan’s nomination from the Democratic Party for the 1896 presidential election further intensified the pro-silver movement because of his platform for “free silver.” Hoping he would win the election, the People’s party and the National Silver party also nominated him for the election. After his nomination, the demand for foreign exchange increased as the dollar holders wanted to convert their dollar to the currencies that were backed by gold. To do so, dollar holders demanded to convert their dollars to gold first by putting more pressure on gold reserves. In other words, the election accelerated net gold outflows (Friedman and Schwartz, 112).

Another view on the cause of the panic is cotton harvest fluctuations due to exogenous variables, such as weather (Hanes and Rhode). Among the main three crops, wheat, corn and cotton, the cotton production fluctuation was the only one to affect the industrial production of post bellum period (Hanes and Rhode). Way the cotton harvest affected the downturn of the business cycle was through the decrease in the reserves in banks and stock price decline. The poor cotton harvest year in 1896 caused a decrease in cotton export and the decline in gold inflow. The cotton export revenue accounted for 25% of the total merchandise export revenue from 1880-1913 (Hanes and Rhode), so a fluctuation in the cotton harvest was one of the factors that could change the business cycle.

The way out of the panic

To stop the gold outflows, a group of gold-shipping and foreign exchange houses agreed to block the outflows. The group borrowed funds in foreign currencies from abroad and exchanged it with the American investors wanting foreign currency and foreigners holding dollars. By doing so, people transferred their dollars into other currencies without first converting them to the gold; therefore, the decline in gold reserves was managed.

When the harvest time came at the end of the August of 1896, crop
export season started and gold inflow started to increase. The victory of the
Republican Party in the presidential election eased the public’s worry about
the US’s departure from the gold standard.

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Enkhjargal (Enjar) Lkhagvajav is a college senior from Mongolia majoring in economics and mathematics at the University of Michigan. He grew up being a math enthusiast. He claims to like studying money rather than making it.